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Thursday, May 30, 2024

So It’s Official: IMF / Carry Trades

So It’s Official: IMF / Carry Trades

Courtesy of Karl Denninger at The Market Ticker

You can put a fork in us down the road….

The U.S. currency dropped against 12 of its 16 major counterparts as the International Monetary Fund said traders are probably using the dollar to fund so-called carry trades around the world and it may still be overvalued.

I hope everyone here in The United States takes a moment to understand what this means.  Let me lay it out for you:

  • When the global economy truly recovers oil will skyrocket up to or beyond the $150 where it was in late 2008.  If the dollar is indeed still "overvalued" and going to 40 as many technicians predict, oil will likely reach $300 a barrel.  This will in turn drive gasoline prices north of $6, heating oil will reach $7-8/gallon, and diesel will be commensurate with heating oil. 
  • This will in turn decimate the trucking industry.  Now you know why Buffett bought BNI.  Many things he may be, but dumb isn’t one of them.  Trucks will of course remain for terminal-to-door deliveries but for long-haul they will simply be uneconomic.  Those who currently are employed in this business will lose their jobs.  All of them. 
  • The middle class will be decimated.  Those who live in suburbia, who are primarily middle-class Americans, will find themselves faced with commute costs that are double or more what they pay now.  Those in the middle class who live in the Northeast where heating oil is the primary fuel for winter, where natural gas infrastructure does not exist to replace heating oil, will find themselves choosing between heat and food in large numbers.
Surging Oil Industry Brings Opportunity To Rural California

What’s far worse is that all carry trades eventually unwind and in the history of the markets I have never seen it happen in an "orderly" fashion.  Japan witnessed the destruction of the Yen Carry last year and it was horrific.  We will see it in the future – exactly when cannot be predicted with certainty, but that it will happen in an uncontrolled fashion will be.  While this "unwind" will bring relief from sky-high commodity prices it will do so at the expense of asset prices, which will collapse.

Our government has, quite simply, refused to take the steps necessary to stem this ridiculous and self-destructive course of action.  Part of the problem does indeed lie with the yuan and China’s mercantilist policies, but this is similar to blaming the drug dealer in the entirety for one’s addiction.  Without the user the dealer has no customer and makes no money.  We have become addicted to cheap Chinese crap, even when it is poisonous (e.g. lead-painted toys or adulterated toothpaste) while refusing to address our own debt imbalances by either government or private interests. 

Oil can and graph with American dollar

The rest of the issue is ours, and ours alone – Bernanke could end this tomorrow by draining the liquidity necessary to cause short term interest rates to rise to 2% – still a very "accommodative" rate, yet one that would make carry trades unprofitable.  He and the rest of the FOMC have refused, even though they’re aware of the extreme distortions this creates in the foreign exchange markets and the draining of productive capital from the "funding" currency source nation that always accompanies carry trades.

The only remaining question is whether these "carry trades" and the dollar depreciation that they cause will continue to levitate the equity markets.  Friday morning there was a stunning correlation between the moves in the dollar and the S&P 500 – but then suddenly about 11:00 AM Central time, it broke down.  Many equity and index futures traders have been essentially using the dollar as their "roadmap" for the last several months – but this is a correlation that only works so long as the decline is both orderly and perceived to continue to be so.  If and when that perception changes the correlation will break with extremely violent results.

We certainly do and will live in interesting times, but thus much I am certain of – the Average Joe will neither understand why oil skyrockets the next time it does, nor will he properly place the blame where it belongs: squarely on Ben Bernanke, President Obama and our Congress.


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